Sterling marches on to reach 26-year high

Sterling has soared to its highest level against the dollar since the early Thatcher era, smashing through resistance to reach $2.0131 as global investors turn ever more bearish on the crumbling US currency.

Data from the Office for National Statistics showing the biggest UK pay rises in two years pushed the pound into uncharted territory, with traders now eyeing the next level around $2.06.

Average earnings rose 4.6pc in March year-on-year. In a further sign of creeping inflationary pressure, the Bank of England reported that capacity use in the service sector had reached the highest since early 2001.

At the same time, minutes of the Monetary Policy Committee released yesterday suggest it had no inkling that CPI inflation would deliver a 3.1pc shock in March. It was counting on "benign" pay deals to cool inflation.

Two hawks voted for a rate rise on April 5, citing credit growth and evidence that firms were ramping up prices. The pair were clearly Tim Besley and Andrew Sentance, who have warned before that inflation risked becoming "unhinged".

Jim McCormick, currency chief at Lehman Brothers, said the pound was now 15pc-20pc overvalued and would fall hard once the Bank had finished raising rates. The markets are pricing in two more rises to 5.75pc in coming months.

"We don't think sterling is the currency that ought to be leading the charge against a weakening dollar," he said, citing a waning appetite for British Gilts among global central banks.

"While there's been a barrage of M&A money coming into Britain, this has now started to turn negative," he said. Britain's current account deficit is 3.8pc of GDP, a sign the currency is over-stretched.

The last time sterling was so strong, in June 1981, booming North Sea oil revenues had turned the pound into a petro-currency. Exchange controls had just been abolished, and inflation - briefly 26pc - was being crushed by a ferocious monetary and fiscal squeeze.

The pound was on its way down, tumbling from $2.41 at the top of the oil boom to $1.05 in 1985, when the Sultan of Brunei intervened.

For global investors, yesterday's sterling story was a sideshow. All eyes were on the dollar as it neared an all-time low against the euro, and gold pushed above $692.50 an ounce for the first time in almost a year on fears that the global currency system is starting to unravel.

Simon Derrick, an economist at the Bank of New York, spoke of a "collective loss of faith" in the main curencies. "We suspect that the forces unleashed over the past few months will only gain in power, " he said.

Investors appear tired of propping up a US economy that needs $900bn a year of foreign capital to meet its spending needs.

Both China and Russia, with the world's biggest ($1,200bn) and third biggest ($340bn) reserves, have signalled that they wish to cut their dependence on dollars. Washington has just enraged both: Beijing with trade sanctions, and Moscow with the new US missile shield in Eastern Europe.

Peter Schiff, chief economist at Euro Pacific Capital, said the dollar "now teeters dangerously close to the edge of a very large precipice", and the US could no longer count on the goodwill of foreign governments.